Are you worried about Liquidity Risk on your portfolio?
Have you been spoilt by a market which did not crash much even though the pandemic is taking its toll on the economy?
On Thursday of last week, the Canadian authorities published guidance directed toward investment fund managers on how to maintain an effective liquidity risk management framework. This is of course not aimed at the individual investors, but it is for us to take a hint. Many people buy a piece of land or a flat to fund a child’s education or their own retirement. Real estate is notorious for liquidity risk.
Liquidity risk occurs in markets where there are very few buyers and sellers. As there are fewer people, it becomes more difficult to determine the correct price to sell or buy an asset for and to actually transact at that price. In the real estate market, this is what happens when you try to sell your house to meet some financial obligations and find that you can’t sell your house for the price that you were expecting to get. In the place where I live there has been no price change in the past 5 years, and the rents HAVE ACTUALLY come down during the Covid epidemic.
If your goal is less than 5 years away, start pulling away say 20% of your less liquid assets – aka equity into ultra-short bond funds. Remember if you own bonds with a 5-year maturity, you need not do anything – the bond will wind itself down anyway. However, if you have money in gilt, then YOU are taking an interest rate call – best of luck.
If you have penny stocks, chances are you might hit 3 days of lower circuit and be locked out of all the action in that shit.
There is a Marwari saying – “the work which money can do, only money can do”. So if you have a liquidity crunch, you need your own money. Things can go wrong EXACTLY when you need the money. Having liquid assets is the best thing that you can do. The current Franklin Templeton problem taught us one thing – in a crisis a Credit Risk fund behaves like a small cap equity portfolio.
So if you are 58 years of age, do remember that the next 5 years expenses may have to come from your portfolio as soon as you retire. Or if you daughter is in class 9, remember that in 2023 she might ask you for Rs. 25L for a Medical seat – and it will be Rs. 25L per year for 5 years. Do you have that liquidity?
Sadly, Liq Risk is visible, only when it is at your door-step.
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